The central feature of the case was the KPMG scheme, whereby cars were distributed in such a way that the Pendragon Group, the largest car sales group in Europe, avoided paying the output tax owed to the HMRC, ordinarily collected on the vehicle's full retail price. This manifested itself in the three exceptions to the normal payment of VAT that it sought to exploit. The scheme as a whole was otherwise an ordinary commercial financing arrangement of sale and lease-back of vehicles.

VAT is an EU tax governed at the time by the Sixth Directive and thus subject to the EU civil law principle of abuse of law. In Halifax plc v Customs and Excise Commissioners (Case C-255/02) [2006] STC 919 the Grand Chamber set down two conditions for an abuse of law in the field of VAT.

Applied to the context of the current case Lord Sumption found that the first condition, that is a transaction creating a tax advantage adverse to the Sixth Directive, was satisfied. VAT Directives are designed to accommodate normal commercial transactions. The scheme was contrary to EU policy found in the Directive (amended by virtue of Council Directive 94/5/EC of 14 February 1994) and Article 26a, indirectly designed to prevent double taxation.

The second condition, "that it must be objectively apparent that the essential aim of the transactions is to obtain a tax advantage", was also satisfied. It was an essential aspect of the scheme that Captive Co. 5 acquired the cars as a business of going concern, while another captive company assigned the leases of the cars to an offshore bank for no other purpose than tax avoidance.

The First-Tier Tribunal ([20154] STC 844]) had erred in law in their decision that neither requirement was satisfied and that the scheme was not abusive. The decision of the Tribunal on the second Halifax test was wrong in law. Lord Carnwath added that the Upper Tribunal, by virtue of the introduction of the Tribunals, Courts and Enforcement Act 2007, was entitled to remake the decision. It was this decision of the Upper Tribunal that should have been the focus of the Court of Appeal's consideration.

Appeal allowed. The parties were invited by Lord Sumption to agree an appropriate form of declaration or otherwise make submission on the form of declaration in writing within two weeks.

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